BoC turning hawkish? What the analysts say

The Bank of Canada kept its benchmark interest rate at a record low Thursday, but surprised with slightly cheerier commentary that has economists wondering whether the central bank has brightened up enough to entertain a rate hike sooner rather than later.

Mark Carney, governor of the Bank of Canada, highlighted an improving near-term outlook in pretty much every category of concern in his January rate decision, including the European credit crisis, the U.S. economic recovery, global financial markets and the health of the Canadian economy.

“The heightened uncertainty around the global economic outlook has decreased in the weeks since the Bank released its January monetary policy report (MPR),” the bank said in a release explaining its rate decision. “Recent developments suggest that the outlook for the Canadian economy is marginally improved from the January MPR.”

Mr. Carney said the economy will likely grow faster than forecast in the first quarter due to temporary factors, but underlying momentum still points to an expected year of middling growth.

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The governor also described inflation as “somewhat firmer than previously anticipated” due to reduced economic slack and higher oil prices, but remains on track for around 2% after moderating in the second quarter. This is about as close to hawkishness, or leaning towards fiscal tightening, as Mr. Carney got in the comments.

“The BoC’s tone was clearly more hawkish in this statement,” said Stefane Marion and his team of economists at National Bank Financial in a note. “There’s no denying that the North American economy seems to be hitting its stride.”

Mr. Marion forecasts a rate hike by mid-2013 as Canada’s output gap looks set to close earlier than expected.

“Global uncertainties have eased a bit, Canada’s growth outlook looks marginally better, and the inflation outlook is also slightly firmer,” said Avery Shenfeld, chief economist with CIBC World Markets. “Nothing here signalling a rate hike coming soon, but markets will pick up on the slightly improved change in tone on the economy and might move forward the implied date for the first rate hike.”

However, U.S. fiscal tightening may keep North American growth muted in 2013, he said.

“Sometimes it is more important to look at what the bank did not say in the statement,” Sheryl King, economist with BofA Merrill Lynch Global Research, said in a report. “The BoC dropped the comment about symmetric upside and downside risks to the outlook and no characterization of risks was provided. This omission suggests a leaning to upside risks to inflation.”

Charles St-Arnaud, economist with Nomura Global Economics, expects the Bank to raise its rates before the end of the year barring a severe negative shock. In particular, Mr. Carney’s comments that household debt burdens have become the most important domestic risk signal a possible shift in attention, although the Bank has highlighted concerns about that subject many times in the past.

“It suggests that the BoC is more worried about the situation and is likely tempted to act to contain that risk,” he said. “Whether this is done via the price of credit or via the availability of credit should determine the timing.”

However, not all economists are on the same page with the central bank.

Paul Ashworth, chief North America economist with Capital Economics, instead forecasts an interest rate cut to 0.50% in the second half of the year due to what he sees as an inevitable housing collapse.

“If everything pans out the way the BoC thinks it will, then sure it makes sense for them to raise rates. But we don’t think so,” he said. “Even if the external backdrop continues to improve, the domestic situation will not.”

Mr. Ashworth points to the hundreds of condominium towers being built in Toronto alone, and said for the Bank’s projections to hold out cities will have to carry right on building at an unsustainable level. Even a slowdown instead of a collapse could have disastrous implications for employment and economic growth.

“I have no problem saying housing will blow up. We don’t see it so much as a risk as something that is going to happen,” he said. “The governor is in a difficult situation. If he stands up and says ‘You’re all idiots for buying homes,’ then he might trigger the very thing that he is trying to avoid.”